A contractor's guide to Profit and Loss accounts
Nobody likes surprises when it comes to parting with money. That is why it is important for contractors to understand -- and keep on top of -- their limited company accounts when they are the company’s director, writes Christian Hickmott, CEO of Integro Accounting.
If you know where you financially stand, at any given time, when it comes to your final corporation tax figure for example, or say your last big expense, you will be prepared. And to be prepared, making you less exposed to nasty surprises, you need to be all over your company’s Profit and Loss (P&L) accounts.
What are P&L accounts?
Simply put, your P&L accounts summarise your revenue, costs, and expenses during a particular period (usually a month, a quarter, or over a financial year). They will tell you if your business has made a profit or loss during that period.
The P&L accounts are developed from the bookkeeping information usually inputted by you, the contractor/ company director. This gives a full overview of all relevant details, relating to invoices and all company expenses.
A qualified accountant can then develop a comprehensive ‘P&L account statement.’ For those contractors wanting to administer their affairs totally independently, the latest bookkeeping software programmes (such as FreeAgent), can generate a form for you.
What is included in the P&L accounts?
The P&L report includes all revenue and expenses of your business which enables you to see at-a-glance how profitable the business is. So:
- All of your sales -- made up of turnover and any other income.
- All costs -- made up of your cost of sales, overheads, and any expenses.
For your limited company or Personal Service Company (PSC), you should include in the P&L all expenses that are used solely for the running of the business – salary, pension, insurance, accountancy fees, travel, being chief among them.
However, it is worth noting here that some outgoings, such as dividends, are not classed as an ‘expense’ and therefore do not appear on your P&L. A basic example of what you may expect to see can be seen below:
|Period 01/01/2020 to 31/12/2020||£|
|Tax on profit||-27,329|
|Profit for the financial period||115,968|
P&L: Key Terminology
Based on the information we review for our contractor clients; these are some of the key terms you may find useful:
- Gross profit – is your total sales less the costs associated with making, selling, and providing a service.
- Operating profit – the amount remaining after ‘operating expenses’, most commonly if you’re a PSC these expenses are your salary, travel, stationery and mobile phone. To work out your operating profit, subtract these expenses from your gross profit without factoring in interest and tax.
- Net profit – the amount remaining after all costs, expenses and taxes are subtracted from your gross profit including interest.
These are just some of the terms used when producing P&L accounts. Naturally, additional terms and examples will be used dependent on your trade. However a good accountant can advise further on these when your P&L report has been developed.
Why keeping on top of bookkeeping is vital -- and how your P&L is affected
P&L statements are a useful tool for seeing if you need to improve your profit by increasing revenue or by cutting costs.
Keeping on top of your bookkeeping will allow a P&L statement for any given period -- the most common being monthly, quarterly, or annually, with the statement producible with only a few clicks of a mouse.
Not only that, but the profits are also used to calculate the corporation tax that you need to pay to HMRC. At a minimum, a corporation tax return needs to be produced and filed at least once every financial year. And if you do not submit your corporation tax return on time, this can result in HMRC charging interest and penalties, so it is crucial to make sure the reports are submitted on time.
Obviously, your accountant can help you with this and advise what you owe, but the information relating to income and expenditure will need to come from the data provided. If this is not up-to-date, inaccurate figures can be populated, providing an incorrect reflection of the corporation tax owing. So, again, keeping on top of your bookkeeping really should avoid any nasty surprises, and an unforgiving HMRC!
How are P&L accounts different to monthly bookkeeping?
Contractors will usually complete their own bookkeeping which simply means inputting the information relating to what is going in and coming out of their company.
This is the information that is reviewed by your accountant and used to generate your balance sheet and P&L report.
What is a balance sheet?
Along with a P&L statement, a balance sheet is necessary to show the finances of a company in more detail. A balance sheet will show how much your business owns and how much it owes at any given point in time.
The balance sheet is split into two halves – the top showing the business’s assets, and the bottom showing its liabilities.
- Fixed assets, such as furniture and IT equipment
- Current assets, such as cash in the bank and money owing from clients.
- Current liabilities, such as money owed in the form of bills, wages, and taxes due within a year.
- Long-term liabilities, such as loans or long-term leases due in over a year.
Taking away all the liabilities from the assets leaves the figure that is available for the contractor / business-owner to draw out if they choose to (often referred to as Shareholder Funds). It also shows the current worth of the business on the date the report is run.
The combination of the balance sheet (which shows money going in and out at a particular date), and the P&L statement (which shows the income and expenses for that period), will allow even the busiest contractor the opportunity to see their financial position clearly. With such a vision, you’ll often feel prompted to act where necessary, or it will simply give you the confidence that your business is doing well. Or if it’s not doing well, based on your glance at the figures, you now have a handle on where and when to intervene.
What are the benefits of including all expenses on your P&L?
Make sure, as a contractor, that you include all your expenses used in the running of your business. This will mainly include salary, pension contributions, insurance, accountancy fees and travel. Some contractors may be reluctant to include all expenses as doing so will reduce the profit figure, but inclusion can lessen your corporation tax owed, so is more beneficial for you to do so in the long run.
Regularly looking at your balance sheet means you will always be aware of the financial position of your business, and should you need to, can readily take the appropriate steps to improve your position by either trying to increase income or decrease outgoings.
Your accountant will be able to help you use this information to run your business as efficiently as possible. Likewise, your P&L statement will tell you how much profit you are making so you can make informed decisions accordingly. Simple bookkeeping programmes allow you to easily input your data so your accountant can run the reports. As with most aspects of accounting, keeping on top of your bookkeeping will make this a proactive and straightforward process, and when the numbers work, or change in your favour because of your interventions, a potentially rewarding one too.